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How to reduce taxes without busting the budget

A few days ago, Rep. Paul Ryan of Wisconsin waded into a debate among his fellow Republicans about how they should think about tax policy. His words carry weight among Republicans: They almost universally respect his judgment on economic policy, and partly as a result have decided to make him chairman of the tax-writing committee of the House should they keep control of it in November’s elections.

Some Republicans, notably Sen. Mike Lee of Utah, have argued that the party’s perennial focus on cutting marginal tax rates should be complemented by a revival of its occasional interest in tax relief for parents. Lee has proposed a plan that reduces the top tax rate to 35 percent and also expands the tax credit for children.

Ryan has repeatedly said that the goal should be a top rate of 25 percent. And last week, he told the Weekly Standard that he still thinks getting tax rates down should be the priority for tax reformers. Lower rates would improve incentives to work, save and invest, he argued, and thus increase economic growth. Higher growth would benefit households with and without children.

This is a friendly disagreement among Republicans about what to emphasize. And Ryan’s remarks point to a way it can be overcome.

Some conservatives have argued that although cutting rates would be desirable, the economic effect of doing so is bound to be smaller the lower the rate is. Cutting the top rate to 50 percent from 70 percent, as in President Ronald Reagan’s first term, meant increasing the after-tax return on a dollar earned to 50 cents from 30 cents. That was an increase of 67 percent. Reducing today’s top rate of roughly 40 percent to 25 percent — assuming that was politically feasible — would, on the other hand, improve incentives by only 25 percent.

Ryan countered in his interview that cutting rates is actually more important than ever. That’s because the United States is less dominant than it was in Reagan’s day, capital has become more mobile, and many businesses pay under the individual income tax.

These are better arguments for reducing taxes on investment, including business investment, than for cutting income-tax rates. Rep. Devin Nunes of California has advocated allowing businesses to write off the full cost of their investments immediately, and making up for the lost revenue by ending tax breaks for business borrowing. That would make the U.S. a more attractive destination for investment in a world of mobile capital, and thus promote economic growth.

You can’t draw up a realistic budget with a top tax rate of 25 percent and a large child credit. (You might not be able to draw up a realistic budget with a top rate of 25 percent even without the credit.) You probably can, however, draw up one with a lower top rate than we have today and better treatment for investment — including parents’ investment in the next generation. Because that mix of policies would leave many millions of middle-class families ahead, it may well be easier to enact than a plan that concentrates solely on reducing the top rate. Supply-siders, that is, might achieve more of the rate reduction they seek if they embrace the credit.

Combining these ideas, as Sens. Lee and Marco Rubio of Florida are now trying to do, seems like the obvious sweet spot for Republicans. It would allow them to be both pro-business and pro-middle class, pro-growth and pro-family. And if Chairman Ryan came on board, the party would find itself in a new friendly agreement.

Ramesh Ponnuru, a Bloomberg View columnist, is a senior editor for National Review, where he has covered national politics for 18 years, a visiting fellow at the American Enterprise Institute and a resident fellow at the University of Chicago’s Institute of Politics.